Medicare and Social Security: The Challenge of Giant EntitlementCosts

Medicare and Social Security: The Challenge of Giant EntitlementCosts

Social Security and Medicare have promised $42.9 trillion more
in benefits to senior and disabled workers than the programs will
be able to pay, according to a new report. The 2008 annual report
of the trustees of the Social Security and Medicare trust funds
concludes that both programs will require progressively larger
transfers from general revenues to maintain projected levels of
spending. The burden from Social Security and Medicare will fall
directly on younger generations, and this report affirms the need
for Congress to begin a serious overhaul of both of these vital
programs.

Medicare Funding Warning

Congressional inaction on entitlements imposes huge costs on
current and future taxpayers. Under the Medicare Modernization Act
of 2003 (PL 108-173), Medicare's Trustees are required to issue a
"funding warning" if, two years in a row, they determine that
general tax revenues would be required to cover more than 45
percent of Medicare's total costs within a seven-year period.

The "funding warning" was issued last year and required the
President to propose remedial legislation to bring the funding back
into balance. The President's legislation (H.R. 5480), which
proposes medical malpractice reforms and higher premiums for drug
coverage among upper-income seniors, is not expected to receive
serious consideration by Congress.[1]

The 2008 Trustees Report issues the "Medicare funding warning"
once again: "The difference between Medicare's total outlays and
its 'dedicated financing sources' is estimated to reach 45 percent
of outlays in fiscal year 2014, the seventh year of the
projection."[2] This is the third such consecutive finding.
Congress has no legitimate excuse for refusing to act.

Medicare's Financial Crisis

Of the two programs, Medicare presents the greater challenge to
Congress and taxpayers. The first wave of the 77-million-strong
baby boomer generation will start to retire under Medicare in 2011,
stimulating a higher utilization of new and more expensive medical
technologies. There is no substantive improvement in the outlook
for the Hospital Insurance Trust Fund, which is still projected to
be exhausted by 2019. The rapidly rising cost of the Supplemental
Medical Insurance (SMI) program, which is mostly funded
through general revenues, is the source of the largest portion of
the Medicare unfunded obligations.

According to the Trustees, "Within the next 5 years, general
revenue transfers are expected to constitute the largest single
source of income to the Medicare program as a whole--and would add
significantly to the Federal Budget pressures."[3] Medicare's total
unfunded obligations, based on the Trustees' 75-year actuarial
projection, is estimated to be $36.3 trillion.[4]

Current and future taxpayers will be faced with enormous burdens
in trying to sustain the Medicare program as it is today. Few
expect Congress to raise beneficiaries' premiums to a level
sufficient to cover Medicare's shortfalls. Likewise, few expect
Congress to cut off Medicare benefits to seniors, at least in any
explicit fashion. Realistically, if Congress refuses to address
rapidly rising Medicare spending, then it would perforce require
Americans to pay taxes at a level far exceeding anything Americans
have paid before.

Tax increases could come in the form of increased federal income
taxes or payroll taxes. An independent estimate by Professor Thomas
Saving of Texas A&M University, a former trustee of the
Medicare and Social Security trust funds, models a payroll tax
required to pay for current and projected Medicare deficits. While
holding the non-entitlement expenditure share of the gross domestic
product constant, Saving estimates that today's Medicare payroll
tax of 2.9 percent would jump to 5.7 percent in 2020 and 9.3
percent in 2030.[5]

The only responsible policy option for Congress and the
Administration is to embark quickly on serious reform of the
Medicare program, changing it from an open-ended entitlement to a
defined-contribution program, adjusting government contributions to
seniors for age, health costs, and income.

Social Security's Growing Deficits

In present value terms, Social Security owes $6.5 trillion more
in benefits than it will receive in taxes. That number includes
$2.2 trillion, in net present value terms, to repay the bonds in
Social Security's trust fund and $4.3 trillion to pay benefits
after the trust fund is exhausted in 2041. While this is a decrease
of $0.3 trillion from last year's report, almost all of that change
results from a technical change in the methodology used to make the
estimate. If last year's methodology had been used, the total
deficit would have been $7.3 trillion.

Net present value measures the amount of money that would have to
be invested today in order to have enough money on hand to pay
future obligations. In other words, Congress would have to invest
$6.5 trillion today in order to have enough money to pay all of
Social Security's promised benefits between 2017 and 2082. These
funds exclude what Social Security receives during those years from
payroll taxes.

Social Security will continue to collect more in taxes each year
than it will spend on benefits until 2017, the same year as in the
2007 report. The trust fund will run out of money in 2041, also the
same year that was reported in last year's report.

This year's report makes a major change in the way that legal
and illegal immigrants are counted that greatly increases estimates
of the numbers of illegal immigrants who are paying payroll taxes.
Most of these workers are estimated to have left the country by the
time that they retire, so the report also reduces its estimate of
the number of immigrants who eventually end up receiving benefits.
These changes offset projected increases in Social Security's
deficits caused by changes in lifespan and other factors.

What most reports will miss is that Congress will have to start
to deal with reduced surplus Social Security tax collections much
faster than it or the public expect. Starting in 2010, the roughly
$80 billion in annual Social Security surpluses that Congress has
been borrowing and spending on other programs will begin to shrink.
From that point on, Congress will have to either find other sources
to replace the borrowed money or reduce spending. The surpluses
will end completely in 2017, the year when Social Security begins
to spend more than it collects.

In 2020, a little more than 12 years from now, today's $80
billion annual Social Security surplus will turn into a $75 billion
annual deficit--a $150 billion change. From 2017 on, Social
Security will require large and growing amounts of general revenue
money in order to pay all of its promised benefits. Even though
this money will technically come from cashing in the special-issue
bonds in the trust fund, the money to repay them will come from
other tax collections or borrowing. Moreover, the billions that go
to Social Security each year will make it harder to find money for
other government programs.

Conclusion

The 2008 Medicare and Social Security Trustees Report shows that
the two entitlement programs cannot remain in their current forms.
It is irresponsible to saddle our children and grandchildren with
the trillions in additional taxes that will be needed to pay full
benefits into the future. Making matters worse, this cost continues
to grow every year.

Unless Congress begins to work now to fix this country's most
important programs for senior citizens, our children will face the
choice of paying for programs for their parents or paying for
education for their children. The first baby boomer has already
retired under Social Security. Delay will only make that dilemma
worse.

David C. John is Senior
Research Fellow in Retirement Security and Financial Institutions
in the Thomas A. Roe Institute for Economic Policy Studies, and Robert E. Moffit, Ph.D.,
is Director of the Center for Health Policy Studies, at The
Heritage Foundation.

[1]For
a brief discussion of President Bush's Medicare proposals to meet
the legal requirements of the Medicare "trigger" law, see Robert E.
Moffit, Ph.D., "The President's Medicare Budget: A First Step
Towards Entitlement Reform," Heritage Foundation WebMemo No.
1797, February 5, 2008, at www.heritage.org/research/healthcare/wm1797.cfm
.

[5]Thomas Saving Ph.D., "Medicare's Future Burden
CBO versus Trustees Estimates," Texas A&M University, Private
Enterprise Research Center, 2008, Slide No. 2. Under Professor
Saving's estimates, the CBO and Trustees data for required payroll
increases would be the same for 2020 and 2030 but, because of
different assumptions, would start to diverge by 2040, with CBO
data yielding a 13.1 percent Medicare payroll tax, as opposed to a
12.3 percent Medicare payroll tax based on the Trustees' data.

Authors

David John

Former Senior Research Fellow in Retirement Security and Financial Institutions